Stock market explained
- How to place orders on the exchange?
Those willing to sell shares enter their orders into the electronic system through brokerage terminal, and those willing to buy set forth their own orders. Exchange automatically checks the entire flow of orders against each other and if there are offsetting orders, which can be satisfied, the transaction is automatically executed and the title for shares is transferred from seller to the buyer. Such a transaction is fixed at a specified price and this price goes to the newscast and to the agencies, as the current price of a particular share.
- Can a private individual trade on the stock exchange?
Yes, but only through a mediator, i.e. a brokerage company that keeps records of transactions, provides reports and provides a dedicated terminal, i.e. a program with interface for order entry. Mediation of the broker has no effect on the time of the transaction, orders appear on the stock exchange in a couple of seconds after entering.
- How much money you need to trade on the stock exchange?
Technologically, there are no such limitations. There are cheap, and very cheap shares. But in terms of the cost of service of the whole process and operations, each broker has its own reasonable minimum. Or otherwise increased commission on services is used. Pay attention to the fact that there exists one of the proven methods to reduce the risk of investment due to the so-called "diversification" of the asset portfolio. The point at issue is that it is optimal to invest in the "basket" of several shares (10-20). With the start-up investor`s capital of 1-2 thousand dollars, any kind of diversification looks unreal. We recommend that you start working on the stock market with the amount of 30-50 thousand U.S. dollars.
- What is a broker?
The broker is a company that provides access to the exchange. It keeps track of client`s operations, provides reporting and a variety of additional brokerage services. In addition, the broker can lend to the customer in real time (so-called margin lending), provide analytics, newlines. For all this, the broker takes a commission or fixed payments for specific services.
How to choose a broker?
First of all, you need to determine your preferences. What is important to you, and what you can sacrifice. The choice may be influenced by the following factors:
- The brokerage fee. This is usually a percentage of the turnover, typically from 0.05% to 0.2%. If you are going to invest for a long time and do not plan to actively control the position, often making transactions, the commission will not be so important. Otherwise, it should be taken into account, because in case of the active trading the value of the costs for the commission can “eat” a large share of the profit. In case of considerable turnover you can safely negotiate with the broker to lower the commission.
- The minimum deposit.
- The possibility of obtaining additional financing. Can be with the leverage from 1:2 to 1:6, and even more, up to 1:10.
- Terminals provided by the broker. Their convenience and availability of the necessary tools for analysis and trade. There are plenty of stock exchange terminals, not all of them are equally comfortable and reliable, and not all of them can have required functions.
- Access to analytics and news lines.
- How reliable brokers are?
All brokers, without exception, working on the provision of access to the organized exchange markets are licensed and strictly supervised by the regulator and the rules of exchanges and trading systems. Here we don`t talk of any unlicensed structures that provide the so-called access to unregulated markets such as interbank FOREX. Well, in reality, it is impossible for a broker to run away with clients' money, because he doesn`t have the money, the money is on the exchange. Therefore, we can say that all brokerage companies operating in the organized stock markets are quite reliable.
- What are the best shares to trade?
Shares of hundreds of different companies are traded on the exchange, but not all of them are equally popular among traders. Its liquidity contributes a lot to the interest in the share; liquidity determines the amount of trading costs in buying and selling. In particular, the liquidity determines the spread, i.e. the difference between the best buying price and the best selling price. If the spread is large, the short-term trading on the share will be very expensive, so less liquid stocks are only good for long-term investment. Also, if there is necessity to buy or sell a significant amount, for a less liquid share it may take some time, or result in additional losses on the slippage. So if you are going to trade rather actively you will have to be restricted to the list of more or less liquid shares. And the more active the planned sale is - the greater liquidity requirements. For intraday trading, for example, you will be probably limited to the few most liquid shares - so-called "blue chips".
- What is a "blue chip" and "second-tier"?
Blue chips are the most liquid shares of the stock market, with the highest turnover of trading. Second tier shares are the less liquid shares, third tier - shares with very low turnover. Such division is rather conditional, there are no clear criteria.
- If I buy shares, where they will be located?
Now almost all the shares are traded in electronic book-entry form. This means that your rights to the purchased shares are confirmed only by an entry in database depository. There are no hard copies, although, of course, it is possible to get a statement from the depositary confirming the fact of your ownership. Custody services are usually rendered by the brokerage company through which you trade. Records of your shares are updated immediately in real time and are reflected in the statistics of your account in the trading terminal on your computer.
- Will I receive dividends on the shares?
Of course, you will. At some point, the company holds closure of the register (cut-off), that is, records of all holders of shares at a certain point of time. Dividends are paid based on the received list. This process is slow and can take several months; the money comes into your account with your broker. It should be remembered that at the time of the cut-off the price of share usually decreases for the amount of expected dividends. Because the register closing usually takes place at the end of the session, which means the gap at the next opening.
- How does the buying and selling of shares work?
In order to buy or sell shares, a trader using the exchange terminal places an order at the exchange indicating the share, the number of lots and the desired purchase or sale price. The order goes to the exchange, where it is automatically checked for the purpose of identification of offsetting orders with the price equal or better than the price stated in the order (for example, for purchase, orders for sale are sought for with a price equal to or less than the one specified in the order). If such an offsetting order is found, the transaction takes place. If there are no such offsetting orders at such price, the order remains in the exchange database and waits until a suitable offsetting order appears or until it is cancelled by the trader. At each moment of trading after opening there are outstanding orders for purchase (bids) and sale (offer). This queue of orders looks as follows: the bids are below (no volunteers to sell so cheap yet), offers are above (no volunteers to buy at such a high price yet), between them there is usually a gap (spread). At the lower boundary of spread there is the best order for purchase, at the upper boundary - the best order for sale. A piece of orders` queue (so-called "glass") can be found in the exchange terminal. When an order for purchase comes to the stock exchange at a price higher than the best sale price, it is satisfied by "eating" of the corresponding piece of offers. When an order for sale comes at the price less than the best purchase price, the upper part of bids is eaten.
- What is the difference between limited and market orders?
Limited order is a common order with the price specified therein. Its principle of operation is described above, i.e. if there are offsetting orders, the order is satisfied, if not, it is put in a queue. In a market order the price is not indicated, it is satisfied immediately at the prices available in the market, no matter what. That is, a market order for purchase is satisfied by the best offer and the market offer for sale by the best bid.
- What is a stop-order?
This is a conditional order, which is executed only when the price reaches the level of the "condition" specified in the order. Stop-order for sale is executed when the price falls to the level specified in the order. This order is used to close a position when prices fall below a certain level. Stop-order for purchase is executed when the price rises above the level specified in the order. It is used either for opening of positions as the price increases or for limiting of losses on short positions.
- What is leverage?
Leverage (margin lending) is a loan that the broker grants to you on the security of your capital. The loan is granted automatically, meaning that you do not have to do anything special to get a loan, you can immediately operate the capital, which is several times more than your capital. The size of the leverage depends on the broker, there are leverages from 1:2 to 1:6 (i.e. for U.S. $ 1 of your money 6 loan dollars are granted, as a result you can buy more shares than at your own expense). Similarly, the leverage is provided by shares playing short. The loan is provided by the broker not for free, there is an overnight fee at the rate of (N% pa / 365 days) where N depends on the broker, usually from 6 to 12%. If the leverage is not left for the night and is used only within the day, then, correspondingly, it is granted for free.
- What is "short"?
Short is selling of shares when initially you do not have the shares, you take them from a broker on credit (margin lending). That is, you sell shares as if you had them, as a result you get a negative number of shares. Then you buy them back, the balance becomes zero, the shares are automatically returned the broker. You took one share on credit - one share is returned, regardless of the price for it. You cannot "short" all shares, only those that the broker can provide in the frame of margin lending. Usually these are a few of the most reliable and liquid shares. Why do we need shorts? To speculate for a fall.
- How to speculate for a fall?
If you assume that the price will fall, you sell shares at short. For example, you sold 1 share at a price of $ 50. You've got $ 50 in cash and minus one share. Say, things happen as expected and the price dropped to $ 40. You buy back the share for $ 40, it automatically returns to the broker and you are left with $ 10 in cash and zero shares. Thus, you have gained a profit of $ 10.
- And what is "long"?
Long is the usual purchase of shares for speculation for a rise. That is, the "long" and "short" are opposite positions. If you have a positive number of shares, you are in the "long" on them, and if it is negative, you are in the "short". These are just historically formed terms. "Long" (long position) to denote speculation for a rise, "short" (short position) to indicate speculation for a fall.
- How much can I earn on the stock exchange?
This is a very complicated question, because the result of your activities on the stock exchange will depend primarily on you. Fluctuations of stock prices are enough to increase your account enormously and to quickly kill it to zero. Your rate of return and your losses will be the result of your chosen course of action in the market, of your trading strategy. However, we can identify the factors that directly affect the possible size of your income:
- Firstly, the size of your capital. It is understood that at one and the same trading strategy income on capital of $ 50,000 would be 10 times higher than the income on capital of $ 5,000.
- Secondly, acceptable risks. If you play carefully, trying to avoid losses below 10%, you will have certain profit. If you take risks significantly, actively playing with the leverage and are ready to keep the losses to 30%, , the potential profit will be higher using the same strategy.
- In general, three-fold excess of the average annual income over the maximum allowable drawdown will be a good result. That is, if you allow a loss of 20% of the account, the average result of 60% per annum will be a good indicator.
- Can I get a regularly monthly income?
No. Market speculation is an activity, involving risks, and so no matter how well you play, it impossible to insure oneself against the element of chance. In addition, the market will not necessarily every month be in condition favourable for your trading strategy. So do not count on a steady income from trading, in this business, sometimes you have to sit for a while without profit or even at a loss.
- What could be the strategy of market speculation?
Bear in mind that, despite a lot books written about speculation, there is no common and "right" way to "earn" on the exchange. The scheme is one for everyone, but everyone interprets it in its own way and makes its own decisions. Everyone is looking for “own” strategy and “own” way to profit from price movements. However, there are common approaches:
- The investment strategy. Potential rising shares are identified, for example, using estimates of the fundamental analysis. Portfolio of these shares is formed in order to keep them for a long time and make a profit at the expense of dividends and growth of their market value. Portfolio can sometimes be revised in the light of any changed circumstances or just on a regular basis, once a quarter, for example.
- Following the trend. The essence of this strategy is the use of the strength of the trend, it is suggested to enter the position when the trend is being formed or has already been formed, and leave when the trend seems to be faint or obvious correction began. A feature of this strategy is the purchase of rising stocks, which is not always psychologically comfortable. However, following the trend is the most profitable strategy, especially in our trend market. The principle of the trend game - "buy high to sell even higher."
- Counter-trend strategy. Often the meaning of speculation is understood based on the principle "buy low, sell high." Shares are bought on the fall in order to sell when the price rises. This approach can lead to success on protracted outsets, when the price often unfolds, but on the trend this strategy often leads to losses.
- Patterns (models). Sometimes price depicts similar structures. You can try to identify the conditions of their occurrence and take a lead from the resulting movement model.
- Playing on news. You can monitor the newsfeed and try to respond quickly to the changes in the news background around particular company. When to buy and when to sell.
- When it is better to buy and sell shares?
When the account is opened, all technical issues have been resolved and the terminal is installed, these issues become paramount. Each movement of prices on the market is subject to a certain set of reasons and grounds, but the price is affected by so many different factors that it is absolutely impossible to predict all price movements. And in fact there is no need to do this. It is not at all necessary to strive for each transaction to be profitable. The goal of a trader is to make a profit during a sufficiently long period of time (at least several months). During this time, dozens of transactions can be performed. It is only necessary that the amount of profitable transactions was greater than the amount of unprofitable ones. For example, some quite successful trading strategies give a plenty of relatively small losses and rare, but large profits, by far covering all losses. Control of losses plays an important role in the practice of speculation. For novice traders, it is especially important, as a beginner is often not ready to psychological stress in case of losses. Having purchased shares, the trader sits down and waits for profit, and in case of adverse developments steadfastly refuses to close a losing position, stupidly watching the losses grow, devouring his account. To avoid such scenarios, it is better to think in advance over the price level at which the position will be closed if the price moves against you. And it is even better to take advantage of the stop limit order (stop-loss). In this case, the position will be closed automatically once the price reaches the level specified in the order. Losses should be cut, no matter how hard it may be.
- Industry indices, which are calculated for a particular sector of the economy (energy, ferrous and non-ferrous metallurgy, oil and gas, banks, etc.). At the bottom of the calculation lie share quotations of the leading enterprises of specific industry.
- Summary (composite) indices, which are calculated based on the share prices of companies in various industries. For selection of companies, two basic approaches are used. The first approach is based on the fact that companies included in the index calculation should reflect the structure of the industries of the national economy. «FTSE-30» index calculated in the UK can serve as an example here.
In terms of financial markets, the main place where majority of the shares of world`s manufacturers of goods and services is traded, is the so-called stock market (Stock Exchange).
Stock exchanges bring together buyers and sellers of shares, which agree on the price and perform purchase and sale transactions. Part of the stock exchanges are physical locations where transactions are made by real people. You can often see on TV trading venues of stock exchanges, where people in multi-coloured jackets with badges stand very close to each other in some area, wave their hands, shout and signal to each other. That is how the process of trading shares goes, with the participation of professional experts. Another part of the stock exchanges is virtual, where exchanges are made up of multiple computers and protected networks through which trades are made electronically.
The main objective of the stock exchange is to provide an opportunity for buyers and sellers to exchange securities, while reducing investment risk. For shares, as well as for other securities, there exist two markets: Primary and Secondary. Primary market is a market in which the securities are issued by a company for the first time, which is called the initial public offering (IPO). Secondary market is a market in which investors buy and sell shares that have already been issued by companies and have no direct relation to them. It is important to understand that the primary market investors buy shares directly from companies, and in the secondary market investors trade shares among themselves, without direct interference of the companies.
Almost every country has its stock exchange where shares of local companies are traded. But there are stock exchanges, which have in their lists shares of companies from all over the world. These stock exchanges include global giants:
- New York Stock Exchange, which has existed for over 200 years and is a home for the shares of such companies as "Coca-Cola" and "McDonald's»;
- Electronic stock exchange NASDAQ trades shares of such companies as «Microsoft», «Dell» and «Intel»;
- The London Stock Exchange is the largest stock exchange in Europe and brings together thousands of various European companies;
- The Hong Kong Stock Exchange is the largest in the Asian region.
The major securities on the stock exchanges are shares and ETF funds.
In addition, transactions with the use of other financial instruments are often performed in the stock exchange. So is trading in options - the right to buy or sell shares in the future at a certain price.
- Ordinary shares
- Preference shares
- Cash (documentary) shares, which are prettily designed and you can hold them in your hands. Such shares are printed by special licensed organizations, such securities contain special characters of protection against forgery.
- Uncertificated shares in recent decades have become widespread due to the level of development of Internet technologies, e-commerce technology and accounting. With uncertificated shares it is easier to conduct transactions electronically, they are easier to control than paper shares. Evidence of the ownership of such a security is an entry in the register of the company that issued the shares.
- Nominal shares, with indication of the information about the owner. The owner of the shares is registered in the documents of the issuing company and all transactions with securities may only be made upon notice of the joint stock company. Nominal shares are usually of high value.
- Bearer shares are not assigned to a specific owner. They are issued in relatively low values and are anonymous. Due to free circulation bearer shares are similar to money. Purchase and sale of these securities mean change of the owner.
- Shares of open joint-stock companies, which are freely bought and sold on the market. They can be sold to another person, without notification of the joint-stock company
- Owning shares of the company, you can receive dividends which are part of the company's revenue. These dividends are your income on your capital invested in the shares of this company.
- If the company whose shares you own, is promising, in demand and respected by investors, the price of its shares increases, which increases your initial investment.
- You are not responsible for the obligations of the company, and if it goes bankrupt, then maximum you can lose is the amount invested in the shares of this company.
- Over the last century shares provided the biggest income to investors in comparison with alternative similar financial instruments (bonds, deposits, etc.).
- Risk of investments in case of proper investing in shares is successfully offset by the chance of getting very high profit. A good example of this is "Microsoft". Ten thousand dollars invested in the shares of "Microsoft" at market entry have turned into millions.